Optimal Investment with Noise Trading Risk

Abstract

This paper investigates the optimal dynamic investment for an investor who maximizes constant absolute risk aversion (CARA) utility in a discrete-time market with a riskfree bond and a risky stock. The risky stock is assumed to present both the dividend risk and the price risk. With our assumptions, the dividend risk is equivalent to fundamental risk, and the price risk is equivalent to the noise trading risk. The analytical expression for the optimal investment strategy is obtained by dynamic programming. The main result in this paper highlights the importance of differentiating between noise trading risk and fundamental risk for the optimal dynamic investment.

Risk management for international portfolios with basket options: A multi-stage stochastic programming approach

“…Second, based on scenario trees, it can handle almost entire distribution of asset returns, especially for portfolios with options with alternative distributions, and thereby allow for a broad variety of objectives and constraints. Strong support for its important contributions can be inferred from diverse applications; see, Klaassen [18] , Gaivoronski, et al [19] , Abdelaziz [20] , Topaloglou, et al [21,22] , Xu, et al [23] , Zeng and Li [24] , He and Meng [25] , Zhang [26] , etc.…”

On asymptotic optimality of Merton's myopic portfolio strategies under time discretization

“…Leland [22], Mossin [25], Merton [24], Samuelson [30], Fama [12], Hakansson [16], Hakansson [17], Elton and Gruber [11], Francis [13], Dumas and Liucinao [10], Östermark [26], Grauer and Hakansson [15], Pliska [28], Li and Ng [23], Xu et al [33], C ¸anakoǧlu and Özekici [4], Zhang and Li [34]. If a discrete time market model is complete, then the martingale method can be used (see, e.g., Pliska [28]).…”

“…Therefore, it is important to extend the class of discrete time models that allow myopic and explicit optimal portfolio strategies. The problem of discrete-time portfolio selection has been studied in the literature, such as in Smith [31], Leland [22], Mossin [25], Merton [24], Samuelson [30], Fama [12], Hakansson [16], Hakansson [17], Elton and Gruber [11], Francis [13], Dumas and Liucinao [10],Östermark [26], Grauer and Hakansson [15], Pliska [28], Li and Ng [23], Xu et al [33], Ç anakoǧlu andÖzekici [4], Zhang and Li [34]. If a discrete time market model is complete, then the martingale method can be used (see, e.g., Pliska [28]).…”